So You're Thinking About Medical Device Manufacturing?

More than 20,000 organizations comprise the $275-billion medical-device industry, which within the next four years is expected to grow to $375 billion, although the number of players is expected to decline dramatically. Despite the expected severe consolidation, manufacturers enjoy numerous opportunities within the medical-device arena, particularly for companies that historically have specialized in metalforming within sectors such as cardiology, orthopedics and neurology.

If you’re considering entering the medical-device industry, there are a variety of factors to keep in mind. Consider this a primer for organizations looking to leverage opportunities within the industry.

Today’s Medical-Device Supply Chain

Fragmented—that’s the best adjective to describe the medical-device supply chain. For example, one of our clients, a $2.5-billion medical-device original equipment manufacturer (OEM), spends $27 million/yr. purchasing products from 283 suppliers. This is not atypical of what we see in the OEM supply base.

The medical-device supply chain also is characterized by a variety of unsophisticated procurement practices, rapid product launches, high launch volumes and low replenishment volumes, and limited supplier involvement in design and planning stages. Moreover, there is a high rate of prototype manufacturers evolving to become production suppliers (which is how the proliferation of suppliers occurred in the first place). We expect to see a number of changes within the next four years.

What’s Changing?

The most significant change expected is severe industry consolidation. There are more than 4000 contract manufacturing organizations (CMOs, the equivalent of Tier 1 automotive suppliers) within the medical-device industry. By 2015, we expect consolidation to result in the formation of 15 to 20 large CMOs around the world. Each of those CMOs will develop its own supply chain and Tier 2 supplier networks.

Once the supply chain consolidates, OEMs and CMOs will become highly focused on cost cutting. And, beginning in 2013, the Patient Protection & Affordable Care Act will place a 2.3-percent excise tax on medical-device manufacturing. This will have a profound effect on the supply base—one OEM estimates that its organization would pay $70 million in taxes in 2013. Industry insiders predict that the tax will reduce profits an average of 4 to 5 percent. Because shareholders likely will not absorb these losses, suppliers will be forced to reduce their costs, perhaps by laying off personnel and cutting R&D budgets, impacting innovation and revenue growth.

We also expect the regulatory environment to continue to become more stringent. The medical-device industry is highly inspection-based, detection-oriented and, therefore, costly and imperfect. There have been some well-publicized spills within the industry during the last decade or so, leading, in some cases, to class-action lawsuits. Due to an increase in the amount of money allocated by the Obama administration to the FDA, 500 new FDA inspectors now are scrutinizing the medical-device supply chain. In some cases, FDA warning letters have literally caused organizations to shut down.

Finally, historically, the medical-device industry has been largely decentralized. Five major OEMs have recently announced initiatives to centralize manufacturing management, supply-chain management and purchasing activities to move toward centers of excellence. This will have a profound effect on supplier relationships.

Questions OEMs and CMOs May Ask Potential Suppliers

How successful an organization will be within the medical-device industry depends on how well it can answer the following questions.

1) How does adding a supplier into my supply deck impact my quality risk? Do you improve quality within the supply chain? This is the door opener for any organization. Are you registered with the FDA? (Unless you’re supplying straight-to-market products, this typically isn’t necessary.) Are you ISO 13485 certified? (This is critical, as some OEMs and CMOs won’t even entertain discussions with suppliers without this certification.) Do you have a robust approach to problem-solving/root-cause analysis? Do you understand the industry vernacular (CAPAs, MDRs, CFR 21, complaints, etc.)? What’s your track record from a quality-performance standpoint?

2) How does sourcing to this supplier impact my total cost? As OEMs or CMOs evaluate adding suppliers, they logically see these entities as work—something else they have to manage that may negatively affect their ability to quickly commercialize products. Suppliers must demonstrate an ability to increase product commercial speed by bringing value—by participating in advanced quality planning, mitigating risk, improving product-launch performance and increasing speed to market.

3) Is the supplier financially stable? Because CMOs have such a fragmented supply base, during the recession it wasn’t uncommon for suppliers to go out of business; many simply didn’t have the financial wherewithal to deal with the changes in production volumes. Although supplier financial stability hasn’t historically been of particular importance, OEMs and CMOs are evaluating it based on these negative experiences.

4) Can the supplier fund further development? Since top-line growth is a major objective for OEMs and CMOs, it’s important that they have the ability to increase capacity and funding, and grow with them. Another significant trend is increased involvement in low-cost areas, particularly the relatively immature markets of Asia, South America and Africa. Suppliers should plan accordingly.

5) Can the supplier provide future cost reductions? Do you have systems in place to improve efficiency and effectiveness and continue to reduce costs, which can be passed along to OEMs and CMOs?

6) What’s the depth of talent of the supplier’s management team? Because of the fragmented supply chain, OEMs and CMOs are used to working with mom-and-pop suppliers, where the talent resides in only one or two people. If that talent leaves, quality and value often leaves with it. OEMs and CMOs have learned this lesson and take this into account.

Getting Started

For companies contemplating entering the medical-device industry, the first order of business is research. Visit shows, such as the Medical Design & Manufacturing Conference. Visit www.fda.gov, where you can view examples of FDA warning letters and recalls and learn more about industry happenings. Subscribe to industry publications, learn the lingo, and then begin to identify potential end products that fit your manufacturing capabilities.

There will continue to be opportunities within the medical-device arena for years to come. Leveraging them won’t be easy, but those organizations willing to expend the effort will reap the rewards. MF